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We’re now in the second Internet bubble. The signals are loud and clear: seed and late stage valuations are getting frothy and wacky, and hiring talent in Silicon Valley is the toughest it has been since the dot.com bubble. The rules for making money are different in a bubble than in normal times. What are they, how do they differ and what can a startup do to take advantage of them?

First, to understand where we’re going, it’s important to know where we’ve been.

Paths to Liquidity: a quick history of the four waves of startup investing.

The Golden Age(1970 – 1995):Build a growing business with a consistently profitable track record (after at least 5 quarters,) and go public when it’s time.

Dot.com Bubble (1995-2000): “Anything goes” as public markets clamor for ideas, vague promises of future growth, and IPOs happen absent regard for history or profitability.

Lean Startups/Back to Basics(2000-2010): No IPO’s, limited VC cash, lack of confidence and funding fuels “lean startup” era with limited M&A and even less IPO activity.

If you “saw the movie” or know your startup history, and want to skip ahead click here.

1970 – 1995: The Golden AgeVC’s worked with entrepreneurs to build profitable and scalable businesses, with increasing revenue and consistent profitability – quarter after quarter. They taught you about customers, markets and profits. The reward for doing so was a liquidity event via an Initial Public Offering.

Startups needed millions of dollars of funding just to get their first product out the door to customers. Software companies had to buy specialized computers and license expensive software. A hardware startup had to equip a factory to manufacture the product. Startups built every possible feature the founding team envisioned (using “Waterfall development,”) into a monolithic “release” of the product taking months or years to build a first product release.

The Business Plan (Concept-Alpha-Beta–FCS) became the playbook for startups. There was no repeatable methodology, startups and their VC’s still operated like startups were simply a smaller version of a large company.

The world of building profitable startups ended in 1995.

August 1995 – March 2000: The Dot.Com BubbleWith Netscape’s IPO, there was suddenly a public market for companies with limited revenue and no profit. Underwriters realized that as long as the public was happy snapping up shares, they could make huge profits from the inflated valuations. Thus began the 5-year dot-com bubble. For VC’s and entrepreneurs the gold rush to liquidity was on. The old rules of sustainable revenue and consistent profitability went out the window. VC’s engineered financial transactions, working with entrepreneurs to brand, hype and take public unprofitable companies with grand promises of the future. The goals were “first mover advantage,” “grab market share” and “get big fast.” Like all bubbles, this was a game of musical chairs, where the last one standing looked dumb and everyone else got absurdly rich.

Startups still required millions of dollars of funding. But the bubble mantra of get “big fast” and “first mover advantage” demanded tens of millions more to create a “brand.” The goal was to get your firm public as soon as possible using whatever it took including hype, spin, expand, and grab market share – because the sooner you got your billion dollar market cap, the sooner the VC firm could sell their shares and distribute their profits.

Just like the previous 25 years, startups still built every possible feature the founding team envisioned into a monolithic “release” of the product using “Waterfall development.” But in the bubble, startups got creative and shortened the time needed to get a product to the customer by releasing “beta’s” (buggy products still needing testing) and having the customers act as their Quality Assurance group.

The IPO offering document became the playbook for startups. With the bubble mantra of “get big fast,” the repeatable methodology became “brand, hype, flip or IPO”.

2001 – 2010: Back to Basics: The Lean StartupAfter the dot.com bubble collapsed, venture investors spent the next three years doing triage, sorting through the rubble to find companies that weren’t bleeding cash and could actually be turned into businesses. Tech IPOs were a receding memory, and mergers and acquisitions became the only path to liquidity for startups. VC’s went back to basics, to focus on building companies while their founders worked on building customers.

Over time, open source software, the rise of the next wave of web startups, and the embrace of Agile Engineering meant that startups no longer needed millions of dollars to buy specialized computers and license expensive software – they could start a company on their credit cards. Customer Development, Agile Engineering and the Lean methodology enforced a process of incremental and iterative development. Startups could now get a first version of a product out to customers in weeks/months rather than months/years. This next wave of web startups; Social Networks and Mobile Applications, now reached 100’s of millions of customers.

Startups began to recognize that they weren’t merely a smaller version of a large company. Rather they understood that a startup is a temporary organization designed to search for a repeatable and scalable business model. This meant that startups needed their own tools, techniques and methodologies distinct from those used in large companies. The concepts of Minimum Viable Product and the Pivot entered the lexicon along with Customer Discovery and Validation.

The playbook for startups became the Agile + Customer Development methodology with The Four Steps to the Epiphany and Agile engineering textbooks.

Rules For the New Bubble: 2011 -2014The signs of a new bubble have been appearing over the last year – seed and late stage valuations are rapidly inflating, hiring talent in Silicon Valley is the toughest since the last bubble and investors are starting to openly wonder how this one will end.

Breathtaking Scale
The bubble is being driven by market forces on a scale never seen in the history of commerce. For the first time, startups can today think about a Total Available Market in the billions of users (smart phones, tablets, PC’s, etc.) and aim for hundreds of millions of customers. And those customers may be using their devices/apps continuously. The revenue, profits and speed of scale of the winning companies can be breathtaking.

The New Exits
Rules for building a company in 2011 are different than they were in 2008 or 1998. Startup exits in the next three years will include IPO’s as well as acquisitions. And unlike the last bubble, this bubble’s first wave of IPO’s will be companies showing “real” revenue, profits and customers in massive numbers. (Think Facebook, Zynga, Twitter, LinkedIn, Groupon, etc.) But like all bubbles, these initial IPO’s will attract companies with less stellar financials, the quality IPO pipeline will diminish rapidly, and the bubble will pop. At the same time, acquisition opportunities will expand as large existing companies, unable to keep up with the pace of innovation in these emerging Internet markets, will “innovate” by buying startups. Finally, new forms of liquidity are emerging such as private-market stock exchanges for buying and selling illiquid assets (i.e. SecondMarket, SharesPost, etc.)

Order of BattleEach market has a finite number of acquirers, and a finite number of deal makers, each looking to fill specific product/market holes. So determining who specifically to target and talk to is not an incalculable problem. For a specific startup this list is probably a few hundred names.

Wide AdoptionStartups that win in the bubble will be those that get wide adoption (using freemium, viral growth, low costs, etc) and massive distribution (i.e. Facebook, Android/Apple App store.) They will focus on getting massive user bases first, and let the revenue follow later.

VisibilityDuring the the Lean Startup era, the advice was clear; focus on building the company and avoid hype. Now that advice has changed. Like every bubble this is a game of musical chairs. While you still need irrational focus on customers for your product, you and your company now need to be everywhere and look larger than life. Show and talk at conferences, be on lots of blogs, use social networks and build a brand. In the new bubble PR may be your new best friend, so invest in it.

Lessons Learned

We’re in a new wave of startup investing – it’s the beginning of another bubble

Rules for liquidity for startups and investors are different in bubbles

Pay attenton to what those rules are and how to play by them

Unlike the last bubble this one is not about selling “vision” or concepts.

You have to deliver. That requires building a company using Agile and Customer Development

51 Responses

Indeed, there are big changes since the early 80’s and the halcyon days of the latter 90’s in terms of creating a successful company. The costs and efforts shifted from engineering and development, to marketing and sales. What has not happened is that VCs haven’t caught up in how they allocate investments to reflect this change. I recently wrote about this here: http://bit.ly/h19GsT.

Nope. I’m observing that 1) there’s a bubble, 2) if you don’t agree don’t do anything different, 3) if you do agree, think about what you would do different in a bubble, 4) I offer that in this bubble you need to build a real company, but that visibility is part of your exit strategy. The “built-to-flip” strategy would assume not focussing on users/revenue/business model. I’m not advocating that… yet.

Steve: I love your book and your focus on a process that iterates to find customers and solve customer problems. This is really a model of how to discover a business/model that would work across any of the waves of startup investing you list above.

I don’t see you make that distinction (maybe I missed it) but would ask you emphasize (or correct me) that your model stands above what you see as a next bubble period.

I’d hate to see your model tainted as a “bubble machine” for bubble companies, which it certainly isn’t.

I can’t help thinking that treating an IPO as a liquidity event was already a broken model in the Golden Age. A preferable, admittedly idealistic, alternative model would be one that rewards delivery of sustainable value at scale with consistent compensation for founders and all significant value producers. An IPO should remain a useful tool, but its purpose should be to cross a critical scale threshold by raising capital for the business.

PS. When will Four Steps be available as an ebook? I have a paper copy, but it’s much less convenient. I would promise not to share if you’d email me a PDF.

Whenever you hear “we’re in a bubble!”, you can bet that it is just the beginning (the author said as much), and is a great time to buy. A true bubble, by nature, goes longer than anyone thinks is reasonable.

IPO will get back on the scene that year. I do agree, the bubble is in the valuation of those businesses (Facebook!!!!) But you still need to have a certain business model and huge revenue to go public. Story we heard in 2001 are hopefully over

[…] boom. Than (then, whatever), read this great post from Steve Blank that outlines the ‘New Rules for the Internet Bubble‘. They are spot on and you better be prepared to honor them or bring the skills needed to […]

“driven by market forces on a scale never seen in the history of commerce.”

Does the phrase “Opium Wars” mean anything to you?

We late-moderns think we’re so coll and all, but what they did to open new markets in the 16th-19th centuries is beyond belief. There’s a reason why privateers and private enterprise have common semantic roots.

The bubble is certainly starting to emerge and can be seen in valuations of publicly traded SaaS companies. In 2009 the median valuation was 3.2x the company revenue and in 2010 the multiplier increased to 4.2x. This will continue to rise over the next 2-5 years.
It’s also interesting to notice that larger revenue companies benefit from a higher multiplier. Companies with revenue above the median were valued at 5.2x their revenue while companies with revenues below the median landed at 3.3x.

[…] school and at UC Berkeley’s Haas School of Business, has gone so far as to publish New Rules for the New Bubble. Unlike the last Internet bubble, argues Mr. Blank, the next one will involve “real” […]

[…] of the new Internet bubble have been in orbit for some time. The author of one of the more imaginative scenarios manages to identify the value within the bubble, for those agile enough to grab it. While […]

Amazing insight Steve! It’s crazy to think how things are shifting in the world of start-ups now… I think it would be interesting to see how this plays out with small businesses that are not technology driven because for some reason they believe that they don’t need to adjust to the overall business climate. It’s exciting to see the new model of start-ups and how a Lean Start-Up model can play into a company success. Is there one company that you are aware of that is flying under the radar for this type of innovation that has a good case study to follow?

Very well put. One question, how does your prescription of focusing on building a company with a stronger focus on visibility and wide adoption depend on the market type that you are playing in? Are we speaking strictly about the B2C or B2B2C markets here?

[…] been focused on money and the valuation of companies. That’s the way most commenters have addressed it over the past couple of months. Rather, I look at the state of product innovation in startups and […]

[…] There has never been such a universal invested interest and participation in “startups.” Communities around the world no longer have a mutually exclusive association between startups and Silicon Valley. Startup are everywhere and any community in the world has the ability to build an ecosystem supportive of innovation, creativity and collaboration. Steve Blank gives this a great historical context in a recent blog post. […]

Any advice specifically targeted to B2B companies?
Your final advice covers three points. While “Order of Battle” applies to both B2B and B2C, the latter two seem more skewed towards B2C companies. Knowing that B2B market is quite huge too, how, specifically, does wide adoption and visibility play for B2B companies? Building a brand through social networks doesn’t necessarily seem the right choice.

Andy Law wrote about the death of the advertising agency in Creative Company… The changes in social structure and communication mediums shifts a great degree of influence away from corporations and governments that once could controlled the messages that highly influence contagions. Contagions create bubbles. New organizations will care less about giving away value to people that don’t do the work – this will change the type of bubble we can expect from economic cycles. NFL players are making demands for a higher share of the value they create… As the world becomes more organized the controlling messages that made exploitation possible will also be limited… The traditional IPO may become a less attractive of an exit option… Some yet unknown alternative may emerge… Accountability is on the rise – wiki leaks… All this information noise could make it harder to create wild and crazy bubbles a second time…? The masses have never had more control… exciting times! Fun fun fun!

[…] has generated even more debate about this bubble. Google’s Eric Schmidt, noted entrepreneur Steve Blank, and the New York Times all have recently commented with views supporting the concept of this […]

Having come a from and internet background and not starting with the assumption that software is a “finish product” opposed to an on going process, I find this constant hype pushing of agile rather amusing.

It’s not really that new, we’ve been doing it for years.

Though it is about time the suits caught up with the idea, and got out of the way with their need to control and pigeon hole process and people, to everyone’s detriment.

[…] as well (or better) than he writes. His talk was engaging and energizing. He started his talk (and a blog post I’ll quote here, based on the same topic) discussing a quick history of the four waves of startup […]

[…] seats the ‘stupidity’ of others. And, then there are folks who talk about the Tech Bubble as a real thing, and try to put it into historical context, juxtaposing it against supposed glory days of venture […]

[…] the availability of billions of users justifies the sky-high valuations (and even provide tools to work in the Bubble). Personally, I think the whole debate is misguided because it lacks both actionable conclusion and […]

[…] author of “The Four Steps of the Epiphany” has written several great pieces on the subject (including this one ). So, if you have missed the train, or don’t have that next great ”app” sitting in your hip […]

[…] A couple of key insights included in the panel discussion came from an overview of the recent trends in the venture capital arena. The presenters pointed out that while activity in the IPO market has increased in recent months from a 35- year low in 2008, there has been a new trend of increasing consolidation among VC funds so that fewer funds are now in control of a larger share of the VC investment dollars out there. One Partner also explained that the percentage of companies making an exit through an Initial Public Offering (IPO) has increased in recent years, while the age of acquired companies has decreased from the decade high of 6.5 years in 2007 to 4.6 in 2011. However, the Partner suggested that this trend has been largely driven by investment demand for new social media companies (For an excellent discussion on this topic, see Stanford Professor Steve Blank’s New Rules for the New Internet Bubble) […]

[…] school and at UC Berkeley’s Haas School of Business, has gone so far as to publish New Rules for the New Bubble. Unlike the last Internet bubble, writes Mr. Blank, the next one will involve “real” […]

[…] think I agree with guys like Mark Suster, Fred Wilson, and Ben Horowitz (no lack of deference to Steve Blank). There is no bubble, but things are definitely getting bubblicious. Entrepreneurship ← […]

[…] author of “The Four Steps of the Epiphany” has written several great pieces on the subject (including this one ). So, if you have missed the train, or don’t have that next great ”app” sitting in your hip […]

[…] If Steve Blank is right , and things do blow up in 2014, it’s possible that a few of the big Y Combinator successes like Airbnb or Dropbox will have gone public and retail shareholders will begin to have a ‘perceived share’ in YC’s success. This will have very little to do the reasons why the bubble, if it exists bursts, but people love rationalizing after the fact. I can see Demo day euphoria being referenced as a sign that things had gotten out of hand in spite of the fact that it has little predictive value today as to when the market might collapse. […]